Nine Takeaways From Earnings Season

With earnings season now virtually over, it is time to ask why, despite a majority of the companies beating expectations, is the S&P inline with where it was when earnings season started. There are two main reasons why the market has not been impressed: the percentage of "beaters" is nothing spectacular on a historical basis as was shown previously, especially in the aftermath of aggressive cuts to Q1 top and bottom line forecasts heading into earnings reports; more importantly, even with Q1 earning coming out as they did, the bulk of the legwork still remains in the "hockeystick" boost to the bottom line that is completely Q4 2012 loaded, as bottom up consensus revisions to the rest of 2012 are negative despite Q1 beats. As Goldman summarizes: "1Q 2012 will establish a new earnings peak of $98 on a trailing-four-quarter basis. With 88% of S&P 500 market cap reported, 1Q EPS is tracking at $24.10, 1% above consensus estimates at the start of reporting season and reflecting 7% year/year growth." So far, so good. And yet, "Despite the positive surprises, full-year 2012 EPS estimates are unchanged relative to the start of earnings season, and currently stand at $105 vs. our top-down forecast of $100. Over half of consensus 2012 earnings growth is attributed to 4Q. Margins at 8.8% have hovered near peak levels for a year, but consensus expects a sudden jump in 4Q to a new peak of 9.1%. We forecast a further decline to 8.7%."

As a reminder Q4 is when all the unanswered questions are expected to clash violently: to NEW QE or not to NEW QE, the "5% of GDP" fiscal cliff, US elections and the 18th National Congress of China, the debt ceiling, and not to mention Europe which will be there all along. And let's not forget Apple: "Apple is likely to be the top contributor to S&P 500 EPS this
quarter. Exxon (XOM) had been the top S&P 500 EPS contributor since
2003, but Apple surpassed it last quarter." If something happens to the coolness factor of AAPL, watch out below. Hopefully margins will somehow find a way to boost themselves to all time records among all this uncertainty.

Going back to Goldman, here are the firm's nine takeaways from Earnings Season:

A total of 421 firms in the S&P 500 have now released 1Q 2012 results representing 88% of the equity cap. Below we highlight 9 takeaways:

1. More surprises than average. The percentage of firms beating consensus EPS expectations by more than one standard deviation (our definition of a positive surprise) exceeds the historical average. The number of firms missing by more than one standard deviation is in-line with the average. Of the 421 firms that have announced results this quarter, 42% of firms beat expectations and 13% have missed. The ten year historical average of beat and misses equals 40% and 13%, respectively (see Exhibit 1).

2. Earnings above expectations. 1Q EPS is tracking 1% above the consensus estimate at the start of reporting season, $24.10 vs. $23.88 (see Exhibit 2). The median surprise over the past ten years has been 1.8%. The 1Q estimate fell by 3% between the start of the 4Q 2011 reporting season in mid-January and the start of the 1Q 2012 season in early April, which aided the level of surprise. Accounting differences between adjusted and operating results for PRU and PFE reduced aggregate earnings level.

3. Investors rewarded firms that beat on both top and bottom line. Stocks that beat on earnings and sales generally outperformed the S&P 500 during the week following the announcement. Of reporting S&P 500 companies, 96 stocks or 23% beat both consensus earnings and sales. More than 70% of firms beating on both top- and bottom-line outperformed the S&P 500 during the next week (see Exhibits 3 and 4). Stocks that beat on earnings and sales outperformed the S&P 500 by an average of 195 bp. Likewise, stocks that missed earnings expectations were more likely to underperform. Only 23% of S&P 500 stocks that missed earnings expectations outperformed the index during the next week.

4. EPS growth of 7% vs. last year. On a quarterly basis, 1Q 2012 EPS will post year/year growth of 7% vs. 1Q 2011 while sales for S&P 500 (excluding Financials and Utilities) will rise by 7%. Industrials and Info Tech EPS grew by 20% and 18%, respectively (see Exhibit 5). On a trailing four quarter basis, 1Q 2012 will establish a new EPS peak of $98.

5. Info Tech growth is Apple growth. Apple (AAPL) earnings surged by 96% and represented 26% of the Info Tech sector’s expected 1Q 2012 earnings. The Information Technology sector is expected to grow earnings by 18% year/year, but by just 4% excluding AAPL. Apple is likely to be the top contributor to S&P 500 EPS this quarter. Exxon (XOM) had been the top S&P 500 EPS contributor since 2003, but Apple surpassed it last quarter.

6. Earnings beats in our basket of cyclically-attractive risk/reward stocks imply further recovery of the corporate sector. 47% of reported constituents beat consensus earnings expectations by at least one standard deviation and no stocks missed. Of the stocks that beat, most were exposed to business fixed investment and inventory re-stocking. Stocks with auto sales exposure met expectations. Constituents exposed to residential investment have yet to report. Since the beginning of earnings season, GSTHCARR underperformed the S&P 500 by 24 bp. Year-to-date, GSTHCARR has outperformed the S&P 500 by 553 bp.

7. Margin stabilization continues. Trailing-four-quarter net margin for the S&P 500 (ex Financials and Utilities) is tracking at 8.8%, near peak levels of 8.9%. Margins have been hovering at this level for the past year, and consensus expects margins to remain at this level through 3Q 2012. Analysts forecast a sudden jump in margins to a new peak of 9.1% in 4Q 2012 while we forecast further slippage to 8.7% (see Exhibit 6).

8. Positive 1Q surprises, but negative revisions to future quarters. Bottom-up consensus revisions to remainder of 2012 are slightly negative despite 1Q beats (see Exhibit 7). Since the start of earnings season, 2012 bottom-up S&P 500 EPS estimates are down 0.5% for 2Q, down 0.4% for 3Q, and down 0.5% for 4Q. Year-to-date, 4Q is the only quarter in 2012 for which consensus estimates have increased. Full-year 2012 estimates remain $105 versus our top-down forecast of $100.

9. Bottom-up consensus expects S&P 500 earnings will grow by 9% in 2012. More than half of the growth is attributed to 4Q. Consensus expects Energy earnings to decline by 7% in 2Q and 12% in 3Q versus 2011. As a result, S&P 500 quarterly earnings growth is expected to be just 4% in 2Q and 6% in 3Q. 4Q earnings are expected to grow 20% versus 4Q 2011, more than twice as fast as any other quarter. Poor 4Q 2011 results explain some of the growth discrepancy between quarters, but not the difference in revisions. If analysts were to lower their 4Q estimates, this would reduce full-year 2012 estimates closer to our forecast of $100. The major earnings weeks are over, but 12% of the S&P 500 equity cap has yet to report including 40% of Consumer Discretionary market cap. Next week, 32 stocks representing 5% of the S&P 500 equity cap is scheduled to release results. Key stocks to watch include: CSCO, DIS, ESRX, NWSA, PCLN and DTV. See page 6 for next week’s calendar.